A golden opportunity beckons

Reducing gold import duty is a strategic initiative with far-reaching implications for India's economy and gold market.

By V Shunmugam, Mudit Sampat and Piyush Pathak

The recent announcement by India's Finance Minister, Nirmala Sitharaman, to reduce the import duty on gold from 15% to 6%, effective 24th July 2024, has sparked widespread interest and speculation. While the initial reaction linked this decision to the financial burden associated with Sovereign Gold Bonds (SGBs), a deeper analysis reveals a more nuanced strategy aimed at reshaping India's economic landscape, curbing illicit activities, and setting the stage for comprehensive gold market reforms.

Beyond Sovereign Gold Bonds: The Broader Picture

Sovereign Gold Bonds (SGBs) have been a successful investment option since their inception in 2015, offering returns and a 2.5 percent annual interest. The duty cut indeed results in potential savings for the government in SGB redemption, estimated at around Rs1,387 crore for maturing bonds (including those that are effectively on a put option starting from now). However, that’s only a part of the picture, and here’s why it was not done with the sole intent of reducing the redemption burden that is too small compared with the loss of the exchequer with the duty reduction.

The FY 2024 data shows that the value of imported gold stood at Rs 377,982 crore. With the duty cut, the revenue loss from reduced customs duty collection is estimated to exceed Rs 34,000 crore. However, lower gold prices are expected to boost imports, which could slightly offset the revenue reduction.

Addressing Smuggling and Boosting Legal Imports

Smuggling is fundamentally a risk-versus-return game, where smugglers weigh the potential profits of illegal activities against the associated risks. By lowering the duty, the government effectively reduces the returns on illegal smuggling operations, including the new form of "mule back" smuggling, where individuals carry gold illegally across borders. This reduction in duty diminishes the incentives for such high-risk smuggling methods, thereby boosting the prospects for legal imports that enhance market transparency. As domestic gold prices align more closely with global rates, the arbitrage opportunities that typically fuel illegal activities are reduced. Consequently, as more gold enters the market through official channels, the increase in legal imports is expected to offset some of the revenue losses from the reduced customs duty.

Strengthening the Domestic Jewellery Industry

The duty cut is also set to strengthen India's domestic jewellery industry. Making gold more affordable encourages Indian consumers who might otherwise travel to places like Dubai to shop for jewellery to purchase locally, thereby reducing revenue leakage. This shift in consumer behaviour boosts the domestic market and enhances the competitiveness of Indian jewellers on a global scale.

Aligning with CEPA and Global Standards

The duty reduction is strategically aligned with the Comprehensive Economic Partnership Agreement (CEPA) between India and the UAE. Previously, the tariff advantage for UAE-based importers was a substantial 9 percent, making imports from UAE more attractive than domestic purchases. The new 1 percent duty advantage for UAE imports promotes a level playing field, encouraging Indian consumers to support local jewellers.

Boosting Gold-Based Savings and Encouraging Market Reforms

Reducing import duty will likely encourage gold-based savings among Indian households from rural to urban areas. With gold becoming more accessible, it is a robust savings instrument that appeals to a broad demographic. This strategic move opens the door for much-needed reforms in the gold market. The government should consider setting up price benchmarks and quality standards that align with global standards like the London Bullion Market Association (LBMA).  This will align India-manufactured jewellery with global standards and the refined or recycled gold swappable across the world. The duty cut also impacts gold Dore imports, affecting refiners and reducing refining margins. Establishing standards similar to the LBMA regime for refining and recycling would bolster these sectors despite margin pressures. By providing a quality framework, India can enhance its gold recycling capabilities, reducing import demand in the long run.

The Case for a Self-Regulatory Organisation (SRO)

Given the strategic moves to enhance global connectivity through tariff reduction, it is time for India to consider promoting a Self-Regulatory Organisation (SRO) for the gold market. This SRO shall be responsible for:

1. Price Benchmarking and Quality Administration: Developing price benchmarks that reflect the Indian market's realities and ensuring adherence to quality standards that align with global norms. The SRO should follow the principles of the International Organization of Securities Commissions (IOSCO) in assessing and announcing these benchmarks.

2. Enhancing Gold Logistics: Improving the efficiency of gold logistics by making inter-market movement more cost-effective, reducing intermarket arbitrages, and connecting disparate markets into a unified national framework.

3. Promoting Recycling and Market Integration: Encouraging recycling initiatives and fostering the development of markets for recycled gold and standards. This will ensure the long-term sustainability of India's gold market and reduce import dependency.

Conclusion: A Path Towards Comprehensive Gold Market Reform

Reducing gold import duty is not just a tactical move to manage bond repayments; it is a strategic initiative with far-reaching implications for India's economy and gold market. By addressing returns to smuggling, strengthening the domestic jewellery industry, and aligning with global standards, India is paving the way for a globally integrated and robust market.  It will provide for transparency in India’s gold consumption to account for while the markets price gold.  Establishing a Self-Regulatory Organisation (SRO) would be a significant step in this direction, providing the necessary framework for setting the national price benchmark, quality assurance, and market integration. By fostering an environment conducive to innovation and efficiency, India can position itself as a global leader in the gold market, leveraging its rich heritage and dynamic economy to create a sustainable future besides converting the revenue loss into an opportunity.

(V Shunmugam is a Partner, MCQube. Mudit Sampat and Piyush Pathak are Emerging Scholars in Finance from the National Institute of Securities Market)